I HOLD THIS TRUTH TO BE SELF-EVIDENT, THAT A DEBT CRISIS CANNOT BE RESOLVED WITH MORE DEBT

Friday, May 7, 2010

Gorillas In The Drawing Room

One of these days the entire world is going to wake up and realize that its debt problems are one heck of a lot bigger and more serious than Greece, which is just the first Debtopia to unravel. That it's not the debts of Portugal, Ireland, or even Spain that may cause the entire post-WWII financial system to come crashing down.

But that it is the United States, with a total debt load of $53 trillion (380% of GDP) and monstrous unfunded medical and pension liabilities (pick a BIG number, it's all quite fictional anyway), that is the huge gorilla in the drawing room that everyone is studiously trying to ignore.

Financial panics are not created in a vacuum; they are born from a mixture of high leverage, overvaluation and serious negative economic developments that simmer underneath, while complacency drives prices ever upward until there is nothing below to support them. And when the inevitable aha! - ohoh! - oh shit! - what the f*ck?! - moment arrives everyone wants to jump off the trapeze at the same time, only to discover that the safety net that is composed entirely of "faith" is gone.

One of these days people will panic, start selling into a hollow market that has no bids at all, take out sell stops in one fell swoop and force the cavalry to come to the rescue, later claiming that the plunge was - perhaps - some sort of a technical glitch.

It looks to me, then, that yesterday was a dress rehearsal for a bona fide panic, even if it was exacerbated by the prevalence of automated electronic trading in non-traditional venues (i.e. outside of NYSE and NASDAQ) where liquidity suddenly disappeared (and why did liquidity suddenly disappear?). Some will point fingers to such black-box trades in order to explain away the sudden plunge in prices, but my experience tells me it was otherwise.

(Here's a piece of information that may explain massively abrupt declines: thirty or forty years ago most shares were owned directly by individuals. Today this figure has shrunk to around 20%, the rest controlled by professional money managers who, playing with Other Peoples' Money, mostly follow the same play-book.)

The real cause, in my opinion, is the same as a year or two ago: there's just too much debt in the system. Governments and central banks took unto themselves the toxic and defaulted debt of the private sector (mostly financial), but the entire debt is still there - albeit in different form. It was, therefore, only a question of when and where its crushing weight would make itself felt once again.

Let me put it this way: we have painted the gorilla to match the curtains in an attempt to make him almost invisible to those willing to be fooled. But that doesn't mean he's not there.
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Something totally unrelated, I just couldn't resist. Or, maybe, it isn't unrelated? The UK is about to have its first hung Parliament in 35 years.

The following picture is from yesterday's UK elections. David Cameron, leader of the Tories (Conservatives) is at the podium, presumably giving a thank-you speech for being re-elected to his seat in Parliament.

37 comments:

The reality in the UK is that nobody wanted change, just wanting to continue to believe in the debt soaked illusion of the past.

The actions of the Labour government to try and hide the reality mean that the majority of the population have no real idea of the size of the problem that awaits.

(For non-UK readers these actions have included paying the interest on mortgages of the recently unemployed for the past two years and the BoE £200Bn QE and £300Bn 'Special liquidity scheme' buying up Gilts and toxic mortgage assets)

Re: Greece, I read somewhere yesterday that it's the French banks that are disproportionately on the hook for Greek sov. debt (one for Debra there I think)

Oh, and thanks for the Lane-Fox book recommendation Hell, fascinating stuff.

And in the UK, where 52% of all national consumption comes from the public purse (and this before bank looting is even included in those numbers), it will be interesting (sad) to see when push comes to shove who will find their chair out from under them when the music stops playing.

One thing however, I seriously don't think we can predict who it will be.

As of about 6 p.m., all the officials knew was that there had been what one official called “a huge, anomalous, unexplained surge in selling, it looks like in Chicago, at about 2:45.” The source remained unknown, but it had apparently set off algorithmic trading strategies, which in turn rippled across everything, pushing trading out of whack and feeding on itself — until it started to reverse.

A number of high-frequency firms stopped trading Thursday in the midst of the market plunge, possibly adding to the market's selloff.

Tradebot Systems Inc., a large high-frequency firm based in Kansas City, Mo., closed down its computer trading systems when the Dow Jones Industrial Average had dropped about 500 points, said Dave Cummings, founder and chairman of the firm.

Tradeworx Inc., a N.J. firm that operates a high-frequency fund, also stopped trading during the market turmoil, according to a person familiar with the firm.

Mr. Cummings said Tradebot's system is designed to stop trading when the market becomes too volatile, ...

Let me let you in on a little fact. Yesterday's event was a cyber attack by China and NK.... They started to set it up early Wed.... Their target was the mini s&p....

So far from the looks of it, they have succeeded as everyone seems to be pointing the finger in every other direction....... Just do a quick investigation and you will see how all the buying beneath the market was matched with sell stop orders down to "no man's land", where rational minds found it inconceivable to have placed standing buy orders.

They intentional picked P&G as the catalyst for 2 reasons.... 1. the weight it would place on the index and 2. it's relative lack of liquidity off of the NYSE.

Yesterday's event was no accident, no fat finger, no computer glitch. It was a sophisticated bear raid, executed with perfect timing, by brilliant minds.

Combine Selling Algo’s with large redemptions from your institutions, then add it shutdowns of those same high speed algo’s (which every high speed trader did since buys were being triggered on the drop…)

…and viola. You have huge sales with 0 bids. There’s no conspiracy here.

To boot, you had not only institutional cash, but all fgn gov't cash in a full on sprint to get T's yesterday. That's more cash that was not available for buying...

OK... just got news that they've evacuated downstairs... (I'm at north Times square)

All the best, Miss America - Rich Hartmann

p.s. Not sure if anyone caught this pice I just did... (more like a rant. I waited a week to publish it, hoping someone else would bring this crap to light... but nada!)

Conspiracy, tin foil hat, call it what you want... I don't care, you can take it or leave it.... IT DON'T MATTER TO ME.....! All I know is what I saw and how I played it, yesterday was the best year I've ever had and trust me when I tell you that I've been doing this for a very long time......

If I would have had the resources, I would have done it myself. Perhaps not, I'm not a sovereign state that requires respect.

Now, having said that, it's very unlikely that you will hear any official announcements from the reg agencies. I mean really..... What are they going to do about it....? Other than whine....

Perhaps it was Russian renegades however I doubt it. China doesn't conspire, China executes, they are single minded and they have the resources, here and abroad. At aprox. 13.00 ET yesterday, asymmetric, pyramid scale down buy orders were being entered in the minis with 5, 6 and 7 point gaps. All i know is that the HFT trade got nailed to the wall yesterday and again today, they don't know when to shut down. Someone figured out how to nail them and they are going to be scratching their heads all weekend wondering how someone reversed the algorithm on them.

I''m not saying your wrong. I have NO facts to back my case that it wasn't China...

So you could be right? It is interesting.

...but many people don't realize that 2:30 to 3pm is when The Mutual and Pension Funds get their figures on what their net Sub/redm for the day will be.

Ya see, early morning, the traders get the projections, and the custodians/accountants provide them with the days cash availability. They trade!

Come 2:30, Redm/Subs come in, and PM's need to figure out what they are rolling over in Repo's, CD's and Time deposits. Likewise, their STiFs, and various custodial funds need to be aligned to not be OD. At the same time, the banks and the broker houses are doing the same. The brokers are seeing how much they need to borrow to cover the days activity.

...with all this said. I think yesterday's fear (especially on the lead up to yesterday) had redms trumping subs big time. I can say, I too shifted my entire 401k to MMKTs/PIMCOBDs. I was not alone.

Credit agrigole was buying Treasuries from everyone they could!!! Jap banks were killing it because they own and lend tons of the stuff. (Jap banks are still holding T's from the 70's and 80's!!! I don't get the past redeption stuff... but somehow they are grandfathered in on some weird clauses...)

Anyway... what I saw happening was a liquidity freeze. Couple that with the bot trades, and the shut downs... and you've got 0 bids to purchase.

".......Come 2:30, Redm/Subs come in, and PM's need to figure out what they are rolling over in Repo's, CD's and Time deposits. Likewise, their STiFs, and various custodial funds need to be aligned to not be OD. At the same time, the banks and the broker houses are doing the same. The brokers are seeing how much they need to borrow to cover the days activity....."

absolutely, no debate there.... this is every day..... and plays well under stress.... a little nudge goes a long way..... if you match the buying with selling it nets out to zero ie open space fast gaps in hyper space, with lots of volume, however you can't do it in the pits because you cant go through bidders limits because they hand you a beating.... the electronic servers execute without whining.... that's the beauty of the beast....

Sounds like the guy is posting customers on the phone, many of the floor brokers on the exchange floor have phone clerks that are like the color commentators of a sporting event. It keeps the direct clients (big shooters) happy. However, as I mentioned before, that's not where the real action took place, they couldn't even keep up with it on the actual exchange..... The real action was electronic, in the s&p minis... Each mini is half the size of a floor traded s&p, we spend our day doing arbs when the market is slow.... It's a way to kill time at the desk. However, on Thursday, it felt like Tim Geithner sent me an invitation the read...

"...I've instructed the Chairman of the Federal Reserve to open up all the vaults, please, do drop by and help yourself to whatever you want...."

This is choice: "The Chinese don't conspire, they execute." Yes, they execute people, their own, in large numbers. As for pulling off such an audacious gambit, anything's possible, but I strongly suspect your feverish imagination has got the best of you. In the meantime I suggest you contact the media and the authorities and make your case formally. Let us know how it goes.

Forget Repo 105. That has nothing to do with the mutual fund / pension Fd world of Money markets.

(it's a big deal on the broker dealer side, but it's not anything to do with this. (It's more of an off balance sheet bookkeeping loophole for quarter ends.))

Repo. - Tri Party repos, CDs- Cert of Depot, and ECD - European cert of Dep, TD = Time Deposits, STiF - Short Term investment Funds.

Pretty much what these come down to are based on how the particular fund is set up. Certain funds have limits and restriction on how much they can have in each type of vehicle, as well as restrictions of how much they can have against a particular broker, and likewise against a particular typ of collateral.

These vehicles ARE the most liquid form of cash floating around in the investment world. 90% are overnight investments. (the MF and PenFds can't just keep their money in cash. THAT IS A HUGE NO NO! (In the relationship management world, try to explain to the public in a perspectus why you: had cash, AND DID NOT INVEST IT?!?!?! It's egg on the RM and the fund's face. Why would the public put money in to sit, when you can do that on your own???) So that money has to invest. (even if the overnight investment is technically "breaking the buck" because RoI is so low due to the Int rate beiong so low, and the fees of the transactions being takin out in soft dollars.)

That ENOURMOUS bundle of money is liquid in overnight form. and the Broker dealers "B/D" count on this. They set aside all their leveraged collateral to borrow against this nightly. (this is what JPMChase pulled from Lehman!)

...anyhow, this is what I suspect dried up instantly. with net redm. For example, When I used to do custody work for Fidelity, I would typically sign off on about $1.5 billion of wires DAILY, going out to the vehicles to the different B/D's. That was a typical day, and I was co managing (so the other manager was moving the other half. We were 1 of 30 groups at BNY doing the same thing... ...and this was just BNY.

Yes, we are lending circa 2B (~10% of our yearly market financing) at a rate below what we are able to get financed on the market.

What troubles me the most is not that. It is the total opacity of local banks. We know that private debt is around 2/3 times more than state debt. But, for mostly ideological reasons, nobody discusses that.

Euro banks are much more opaque than Gringo banks, and southern European even worse. I have no idea on the time to maturity of the debt of PT banks, no idea on how they are marking their assets, nothing. Maybe they are OK, as they say they are. Should I trust?

The only thing I know is: if a big local bank blows, there is no way the sovereign can protect it without entering an abyss (which it might be getting into, anyway).

In fact a possible black swan in Europe is precisely that: a big bank blows or a big important company (train, utility, ...) cannot roll its debt.

With apologies to Hellasious, I read your posting and your description "the inevitable aha! - oh shit!..." brought to mind the image of a drunk who's just reached the point where his body/stomach revolts at all of the alcohol. I couldn't resist the urge to adapt your story to that of a person who has just reached that point. Not speaking from experience of course. I know this guy... 8^) Hopefully you'll find it amusing.

Hangovers are not created in a vacuum; they are born from a mixture of over-consumption of products that can cause harm in large quantities but that seem, at least initially, to provide only feelings of euphoria. And when the inevitable Uurp! – ohhh! – Oh shit! – Baaaarrrrffff! moment arrives everyone wants to switch to coffee at the same time only to discover the damage is already done; the stomach has started to revolt, cold sweats, heaves. The question is no longer if but when?

One of these days people will swear never to drink again. “Never again and I mean it this time!” And yet we all know they’ll be back soon enough in worse shape, claiming this time is different from all the others.

It seems then this time was a dress rehearsal for the last time. It’s only a matter of time before this leads to a car wreck, a fatality, a ruined life, perhaps all of them. Some will point fingers at those who should have known, who could have acted…

"....... And in the zero-sum nature of the market, please enjoy your next meal as you remember a small amount of it came from my retirement plan.

Bon Appetite...."

Adam Smith gave us the concept of an "invisible hand" that giveth and that's that's how we have conceptionlized that "hand" with our delusional western cultural optimism... The "invisible hand" also taketh way..... "Retirement plan" is an oxymoron. There's an old saying in the pits of the exchanges..... "A trader that dies with money in the bank, died a pre-mature death...." The name of the game is to go out even....

I could be 100% wrong. I’m 100% speculating with my theory regarding last week’s plunge. …but my “speculation” is based on (from my experience / knowledge) what I would think is “common sense” to a person with my specific background.

(Funny analogy based on a true event. About 3 years ago, I went to park my car by the bus stop on a VERY STORMY morning. As I drove down Ridge Blvd from 89th st to 69th st (where the bus stop was), I got to 73rd st, and saw lots of leaves on the ground… Got to 72nd st and saw branches on the ground… Got to 71st St and 70th st and saw SEVERE DAMAGE. Trees down, roofs ripped up and people poking their head out their doors looking dumbfounded. Passed by Ovington and Bay Ridge Ave, and there were branches and leaves down… Parked my car on 69th, where there was no sign of any damage. Myself and others walked back to 70th and surveyed the damage up and down the block. We all concluded… A TORNADO JUST RIPPED THROUGH BROOKLYN!?!?!?! We were sure of it. It was 8am.

Later that night, at about 7 or 8pm, the national weather service, and our local authorities concluded that a Tornado had indeed touched down. 12 hours later!!! ??? !!!)

What I said immediately after the drop, and even posted was a similar severe storm.

You have Algo trading bots in place. They are programmed. They don’t think. During our crisis 2 years ago, our quants realize their faults in programming when buys would trigger during a true collapsing market. My “assumption” is that the quants have now plugged in a short circuit at a certain point. As algo’s and Quant go, they probably “think” alike.

Market activity was DOWN all day, from the get go. Sells/downs HEAVILY outnumbered the Buys. Combine that pressure, with redms in the Money Market world (remember, those MMKTs are the oxygen, lifeblood of the entire market) …and now you have the size of the days drop starting to trigger these new short circuits on the algos…

Perfect storm. There are open sale orders. …and high speed bit/algos are not buying because they are tripping circuits. Then you’ve got MMKT cash coming in short, so you big institutions aren’t just lumping buys either. The NEED cash.

0 bids on buys. Yet there are open sale orders that need filling (but the sells aren’t “thinking” they’re just programmed to do their function, which on the sell order was to sell.) Was it manipulation??? …or poor planning? or those damn variables?

About Me

I was educated as a chemical engineer but spent almost my entire career in finance, particularly in money, FX and bond markets. The name stands for Hell-as-IOUs and the picture points to Quixotic endeavors.